Largest Wealth Transfer in U.S. History is Not Nearly Enough to Cover Social Security Debt
By: Bernard F. Pettingill, PhD. and Federico R. Tewes, BA
The Federal wealth transfer tax system consists of three components: a gift tax, an estate tax, and a generation-skipping transfer tax. Since 2020, herein 73 million Baby Boomers and their tax advisors faced uncertainty because these three components have remained in flux for the last two decades. In this article, the authors explore the history of these three taxes since inception in 1797 to better understand how future American presidencies may act to Baby Boomer generation control transfers of wealth estimated at $68 trillion to the Millennials and their successors.
In 1790, following the American Independence, the U.S. economy witnessed constant instability. The phrase “Not Worth a Continental” evolved from the rampant inflation of the Continental Currency during the Revolutionary War. By the 1790s, three land speculators acquired 40 percent of the land under development around Washington D.C., forming a holding company, and selling company stock to mostly European investors. When the land speculation bubble burst, it created the Panic of 1796 and a collapse of the American economy because both English and American banks had issued commercial paper backed by claims to these same lands. Between 1797 and 1802, the crisis resulted in Federal taxes on asset transfers at death in the United States to finance wars or the threat of wars. For example, President George Washington championed American neutrality during his term, but between 1798 and 1800, a naval battle called the Quasi-War found Washington protecting the American neutrality that was under attack by France. All hands on deck and most asset transfers were averted to financing this war.
The first estate tax was imposed by the Federal government to finance the armed conflict against Spain after the U.S.S. Maine sank off the coast of Havana, triggering the Spanish-American War of 1898. At the end of this war, Spain renounced all claims to Cuba, ceded Guam and Puerto Rico to the United States and transferred sovereignty over the Philippines to the United States for $20 million. Credit for the victory went to then-Secretary of the Navy Theodore Roosevelt and his “Rough Riders.” Because death-related taxes were primarily imposed to finance warfare, the Federal estate tax continued until its repeal in 1902. The assassination of President William McKinley ascended Vice-President Theodore Roosevelt to the presidency, and the beginning of a progressive movement. By 1906, President Theodore Roosevelt changed history in two ways.
First, in 1906, the United States government brought a suit against John D. Rockefeller’s Standard Oil Company (New Jersey) under the Sherman Antitrust Act of 1890. At the time, kerosene oil lighted up the darkness because electricity would not reach 70 percent of American households for another four decades. Additionally, large-scale gasoline demand was in its infancy because the Ford Model T came two years after the government suit against the Standard Oil Trust.
Second, in 1906, President Theodore Roosevelt sought to break large concentrations of wealth held by the stockholders of the Standard Oil Trust, in particular. The Rockefeller fortune alone reached a peak equivalent to $418 billion in today’s fortune. Henry M. Flagler, Samuel Andrews, Stephen V. Harkness, and Oliver Burr Jennings were all stockholders and held enormous individual fortunes. To break these large concentrations of wealth held by individuals, the President proposed a progressive tax on all lifetime gifts and death-time bequests for the purpose that one individual could transfer to their heirs.
Nationwide economic recession emerged immediately after the Panic of 1907, when a 50 percent drop in the New York Stock Exchange during a period of three weeks in October caused numerous runs on banks and trust companies for fear that they would go bankrupt. Intervention by financier J.P. Morgan, who pledged large sums of his own money, successfully shored up the banking system by convincing other New York bankers to do the same. Unfortunately for the Federal government, the inability to inject liquidity back into the market highlighted the impotence of the U.S. Treasury during this financial crisis. The future creation of the Federal Reserve System and the Revenue Act of 1913 were pioneered by financier J.P. Morgan and Rockefeller son-in-law Senator Nelson W. Aldrich. Congress and President Woodrow Wilson made the Act a reality prior to the start of World War I in 1914.
Before entering the War, the United States had remained neutral but an important supplier of munitions and war supplies to the United Kingdom, France, and other Allied powers. The threat of war with Germany pushed the Federal government to enact an estate tax on all property owned by the descendent at his or her death, taxes on certain lifetime transfers that were not intended to take effect until death. This 1916 estate tax is similar to present-day estate taxes that provide exemptions at different amounts of inheritance. For example, the 1916 estate tax exemptions were: 1 percent on the first $50,000 of transferred assets; 10 percent on transferred assets above $5 million; and 25 percent on transferred assets above $10 million. The following year, three years after World War I started, the United States declared war on Germany and remained at war until the ceasefire, nearly 18 months later.
Following the end of World War I, President Woodrow Wilson enacted the Revenue Act of 1918 during which Congress retained the estate tax, but the taxes on transfers under $1 million were reduced. Additionally, the estate tax was extended to life insurance proceeds above $40,000.
Between 1924 and 1926, the Federal estate tax underwent the greatest changes. In 1924, the first gift tax was introduced. The estate tax was changed in three ways. First, increasing the maximum rate to 40 percent from 25 percent in 1923. Second, broadening property subject to the tax to include jointly-owned property and any property controlled by the descendent. Third, State death-related taxes received a credit up to 25 percent on Federal Taxes. In 1926, the gift tax was repealed, and estate taxes were reduced to a maximum of 20 percent on transfers over $10 million. The exemption was doubled from $50,000 to $100,000 and the credit for State death taxes was increased to 80 percent of the Federal Tax.
President Herbert Hoover held office during the onset of the Great Depression. Prior to leaving office, the 1932 estate tax was increased to 45 percent on transfers over $10 million. The exemption was cut in half to $50,000 and a Federal gift tax was reimposed (at 75 percent of estate taxes) for lifetime gifts above $5,000 per year. Under President Franklin D. Roosevelt, in 1934, the estate and gift taxes reached the peak of 60 percent and 45 percent, respectively, for transfers above $10 million. By 1935, the estate and gift taxes reached a peak of 70 percent and 52.5 percent, respectively, for transfers above $50 million. Finally, the exemption was lowered to $40,000.
As stated above, Federal taxes on transfers at death in the United States were imposed to finance wars. This is evident as the estate taxes on transfers above $10 million increased from 25 percent in 1916 to 60 percent in 1934, prior to the beginning of World War II in 1939. During World War II, transfers above $50 million faced a 77 percent estate tax by 1941.
Following the Post-World War II era until 1975, the biggest change in the estate and gift tax was the treatment of life insurance. Under a rule enacted in 1954, life insurance was subjected to estate tax if the proceeds were paid to the successor’s estate or executor or if the decedent retained “incidents of ownership” in the life insurance policy. Additionally, families with small businesses were given a 10-year period to pay the Federal estate taxes according to the Small Business Tax Revision Act of 1958. Before this enactment, life insurance payouts were exempt. Contrary to popular opinion, Federal estate and gift taxes are a small percentage of the total tax revenue collected nationwide every year. The highest percentage of total tax revenue attributed to estate and gift taxes was 2.6 percent in the 1972 fiscal year.
Congress substantially revised estate and gift taxes in the Tax Reform Act of 1976, unifying them into a single graduated schedule that maxed out at 70 percent applied to transfers during life and at death. For the first time and continuing to present, lifetime gifts were cumulative and transfers at death were stacked on top of cumulative lifetime gifts for purposes of determining the applicable marginal rate on such transfers. Additionally, the 1976 Act provided 100-percent marital deduction for the first $250,000 transferred to a surviving spouse. For the first time, generation-skipping transfer taxes became adopted into the Internal Revenue Code.
For multi-generational businesses and farms, it is not unusual for grandparents to transfer assets directly to their grandchildren. Under the Tax Reform Act of 1986, a broader definition of generation-skipping transfers above $1 million included direct transfers from grandparents to grandchildren. Additionally, the Act of 1986 made substantial revisions to generation-skipping transfers by applying a single tax rate to the highest estate tax rate.
Under the double term presidency of George W. Bush, the Economic Growth and Tax Relief Reconciliation Act of 2001 tried to reduce or eliminate Federal estate and generation-skipping taxes by phasing out or ultimately repealing those taxes. In fact, the year following the Bush presidency, the estate and generation-skipping taxes were repealed for only one year (2010).
With Barrack Obama as president, the American Taxpayer Relief Act of 2012 made permanent the estate and gift taxes, but increased the top rate to 40 percent and the exemption became permanent at $5 million. Under President Donald Trump, the Tax Cuts and Jobs Act of 2017 established that for deaths occurring between 2018 and 2025, estate taxes that exceed the $11.2 million exemption are subject to 40 percent estate tax. For married couples, the exemption doubles to $22.4 million, adjusted in the future for inflation.
Currently, most Baby Boomers and their financial advisors are concerned that any future Democratic President will drastically reduce the estate tax exemption to the inflation-indexed exemption implemented by President Obama. According to a Coldwell Banker Global Luxury Report of 2019, the Baby Boomer Generation is expected to transfer $68 trillion to their Millennial successors by the year 2030. Although $68 trillion represents the largest wealth transfer in United State history, less than 1.5 percent of the 328 million population in 2020 have a net worth greater than the $10 million. According to the 2020 Census figures, an estimated 73 million Baby Boomers remain alive to date. This is approximately 22.3 percent of the entire 328 million U.S. population in 2020. If both the Silent Generation and the Baby Boomer generations represent the wealthiest group in the nation, then we can expect them to be in the top quartile of the 328 million people. In other words, less than 5 million Baby Boomers will surpass President Trump’s exemption of $11.2 million for individuals. Historically, the 1972 fiscal year saw the top rate at 77 percent applied to asset transfers above $10 million and the exemption set at $60,000. Since 1797, the 1972 fiscal year collected the highest percentage on record at 2.6 percent of total taxes coming from estate and gift taxes. The authors predict that future tax revenues from estate and gift taxes will not surpass this highest percentage on record because current exemptions were set at $5 million and $11.2 million respectively during the last Democratic and Republican presidencies.
If the future Democratic President reverts the estate and gift tax exemption to those under the American Taxpayer Relief Act of 2012, the inflation-adjusted exemption for 2013, 2014, and 2015 would amount to $5.25 million, $5.34 million, and $5.43 million, respectively. This assumes the top tax rate remains unchanged at 40 percent, during both the Obama and Trump presidencies. According to U.S. population records, less than 3 percent of the 328 million population of 2020 have a net worth greater than the $5 million exemption. In short, fewer than 9.8 million Baby Boomers will surpass President Obama’s 2015 exemption of $5.43 million for individuals.
Democratic Presidential Candidate Bernie Sanders offered the most progressive tax plan to date. If, in the worst-case scenario that the future Democratic President enacts the Bernie Sanders type tax plan, the changes to estate taxes would be dramatic. For example, first, reduce the exemption to $3.5 million and apply a rate of 45 percent to estates below $10 million. Second, estates valued between $10 million and $50 million would be taxed at 50 percent. Third, estates valued between $50 million and $1 billion would be taxed at 55 percent. Finally, the 77 percent top rate would apply to estates valued above $1 billion. This reversion to Obama figures combined with Bernie Sanders input would result in trillions of dollars of windfall to the federal government.
United States population records indicate that less than 4 percent of the 328 million population of 2020 have a net worth greater than the $3.5 million exemption proposed by Senator Sanders. In other words, fewer than 13 million Baby Boomers have a net worth greater than $3.5 million exemption. Furthermore, fewer than 5 million Baby Boomers have a net worth greater than $10 million, i.e. Senator Sander’s next level. For those with estates greater than $50 million, only 1.64 million Baby Boomers qualify.
Despite the promises of Democratic politicians, income inequality cannot be fixed via death taxes because the great majority of millionaires develop without help from family or inheritances. First, a report by the Federal Reserve Board found that only about 2 percent of income inequality can be explained by inherited wealth. Second, over 70 percent of the individuals on Forbes 400 wealthiest people were self-made, meaning they built their own fortunes, rather than having had help from family or inheritances. Third, 73 percent of individuals worth over $3 million in net worth did not accumulate any of their wealth through inheritances, according to the U.S. Trust Survey. Given this evidence, it explains why Republican senators have made attempts to repeal any death taxes.
As of January 2019, Republican Senator Robert E. Latta drafted the Congressional bill H.R. 521 “Permanently Repeal the Estate Tax Act of 2019” and was supported by 8 cosponsors. This bill repeals the federal estate tax, effective for estates of decedents dying after December 31, 2018. Another Republican Senator, John Thune, drafted a similar Congressional bill H.R. 215 “Death Tax Repeal Act of 2019” and was supported by 35 cosponsors. Thune points out that this bill would help safeguard the legacy of American business owners, especially family-owned farms, and ranches who pass the business down to future generations.
Current taxation written for 2021 includes the following. First, the exclusion amount is $11.7 million. Second, for an estate of the decedent dying in calendar year 2021, the aggregate of qualified real property cannot exceed $1,190,000. Third, gifts to any person cannot exceed $15,000 and gifts to a spouse who is not an American citizen are limited to the first $159,000.
As proven via historical evidence presented in this article, income inequality cannot be fixed via a gift tax, an estate tax, or a generation-skipping transfer tax. Although 73 million Baby Boomers might be transferring $68 trillion to their Millennial successors by year 2030, the authors do not believe it will fix the income inequality that Democratic politicians highlight in their platforms. Historically, the highest amount of taxes collected via these three taxes was 2.6 percent of tax revenue in fiscal year 1972, when the exemption was $60,000 and the top tax rate of 77 percent was applied to asset transfers over $10 million.
In the best-case scenario, Republican senators do away with the death tax and family businesses could generate 18,000 private-sector jobs over the next decade, and this growth will impact the American economy.
In the worst-case scenario, Democratic senators adopt the most progressive tax plan created by Senator Bernie Sanders. Although the current exemption is reduced to $3.5 million and estates below $10 million will pay 45 percent tax rate, over 90 percent of the American population will remain unaffected. In other words, the widening income inequality will continue unchanged for the most part.
If Democratic politicians seek to fund everything they promised in this election, the correct tools for the job are the individual income tax, payroll tax, and corporate tax that have been the three largest sources of federal revenue in 2019. According to the U.S. Treasury, the federal government has amassed $103.7 trillions in debts, liabilities, and unfunded obligations as of 2020. This is equivalent to 29 times annual federal revenues. Even if death taxes collect 3 percent of $68 trillion by year 2030, approximately $2 trillion will go to the federal government. Although $2 trillion is a massive windfall to the federal government, it is not nearly enough for the current Social Security debt of $35.2 trillion.
Despite the federal government repeatedly boosting Social Security by raising the payroll tax rate and injecting other taxes into its income stream, the program is facing insolvency. Since 1955, the ratio of workers paying taxes to people receiving benefits has fallen by three times and is projected to fall further. There are three reasons why this ratio is projected to fall further.
First, increases in life expectancies without comparable increases in retirement age. Comparing life expectancy figures from 1940 and 2018, there has been a 44 percent increase in the time spent collecting old-age benefits, while the retirement age had increased by over one year during this period.
Second, the higher birth rate of the baby boom generation compared to other generations. Between 2011 and 2032, the number of people eligible for old-age benefits will triple for every person paying Social Security taxes during this period.
Third, the increasing number of people receiving disability benefits. Between 1965 and 2018, the number of people receiving disability benefits increased five-fold, even though the United States population grew by less than 63 percent.
Contrary to popular opinion, the national debt has not been mainly driven by tax cuts or military spending. Instead, it has been fueled by increased outlays for social programs that provide healthcare, income security, education, nutrition, housing, and cultural services. In 1959, these social programs represented 20 percent of all federal spending. By 2018, these social programs have grown to 62 percent of all federal spending.
The Social Security program has a current debt service of $35.2 trillion, but the ratio of workers paying taxes to retirees receiving benefits is projected to fall further. Because of this, the Social Security program remains insolvent and unlikely to change anytime in the future. At most we can expect the federal government to receive approximately $2 trillion in death taxes from the potential $68 trillion that the Baby Boomer generation will transfer to their children and grandchildren by year 2030. Consequently, these authors conclude that the largest wealth transfer in U.S. history will not be nearly enough to cover the Social Security debt and more drastic tax changes will have to be enacted if the Social Security system, now 82 plus years old, will survive the coming decade.
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